How SEP-IRAs and Solo 401(k)s differ for self-employed people

If you receive 1099 income, you can save for retirement in either a SEP-IRA (Simplified Employee Pension Individual Retirement Account) or a Solo 401(k) (also called a self-employed 401(k) or individual 401(k)). Both let you set aside more money than a regular IRA, but they work differently: a SEP-IRA is simpler to open and maintain, while a Solo 401(k) lets you borrow from your own account and has higher contribution limits if your income is very high. The right choice depends on how much you earn, how much you want to save each year, and whether you might need to borrow from your retirement funds.

Neither account requires you to have employees, and both are designed specifically for people with self-employment income. You cannot open either one based on W-2 wages alone — you must have 1099 income or net profit from self-employment to contribute.

Key Takeaways

  • A SEP-IRA lets you contribute up to 25% of your net self-employment income (with a dollar cap set each year by the IRS), while a Solo 401(k) allows both employee and employer contributions that can total significantly more.
  • SEP-IRAs require almost no paperwork to set up and no annual filing, but Solo 401(k)s require you to file Form 5500 with the IRS each year if your balance reaches a certain threshold.
  • Solo 401(k)s let you borrow against your balance, but SEP-IRAs do not allow loans under any circumstance.
  • Both accounts have the same withdrawal rules: you cannot touch the money before age 59½ without a penalty, and you must start taking withdrawals at age 73.
  • If you hire employees, a SEP-IRA requires you to contribute the same percentage for them as you do for yourself, while a Solo 401(k) does not.

Contribution limits: how much you can set aside each year

With a SEP-IRA, you can contribute up to 25% of your net self-employment income, up to a maximum of $69,000 per year (the dollar limit changes each year; check the IRS website for the current year). Your net self-employment income is your 1099 income minus half of your self-employment tax. If you earn $100,000 in 1099 income, you would calculate your SEP contribution based on roughly $92,000 after the self-employment tax deduction, meaning you could contribute around $23,000.

A Solo 401(k) works in two parts. First, you contribute as an employee (up to $23,500 in 2024, though this amount rises each year). Second, you contribute as an employer (up to 25% of your net self-employment income, the same calculation as a SEP). Combined, these can reach $69,000 per year for most people, but if your income is high enough, you can contribute more. The exact total depends on your net self-employment income and the IRS limits for that year.

The practical difference: if you earn $80,000 in 1099 income, both accounts let you save roughly the same amount. If you earn $200,000, a Solo 401(k) may let you save more because of the employee contribution piece. Check the IRS website or a tax professional for the exact limits in your filing year.

Tax treatment: how contributions and withdrawals work

Both SEP-IRAs and Solo 401(k)s are tax-deferred accounts. You deduct your contributions from your taxable income in the year you make them, which lowers your federal income tax bill. The money grows without being taxed each year. When you withdraw in retirement, you pay income tax on the full amount you take out.

The difference appears in how you file. With a SEP-IRA, you report your contribution on your personal tax return (Form 1040, Schedule C, and Schedule SE). With a Solo 401(k), you also report it on your personal return, but you must file Form 5500-N (a simplified version) with the IRS if your account balance reaches $16,000 or more at the end of the year. This filing is free but adds a step to your tax preparation.

Both accounts follow the same withdrawal rules: you cannot withdraw before age 59½ without paying a 10% penalty plus income tax on the amount. You must start taking withdrawals at age 73 (called Required Minimum Distributions or RMDs), and the IRS calculates the minimum amount based on your age and account balance.

Loans: borrowing from your own retirement savings

A Solo 401(k) lets you borrow from your account balance. You can borrow up to 50% of your vested balance or $50,000, whichever is less. You repay the loan to yourself with interest (you set the interest rate, but it must be reasonable). If you repay on time, the loan does not count as a withdrawal, so you avoid the 10% penalty and income tax.

A SEP-IRA does not allow loans under any circumstance. If you need to access your money before retirement, you must withdraw it, which triggers the 10% penalty and income tax if you are under 59½. This is a hard limit — there is no exception or workaround within a SEP-IRA structure.

This is often the deciding factor for people who think they might need emergency access to their savings. A Solo 401(k) gives you that option; a SEP-IRA does not.

Setup, paperwork, and ongoing maintenance

Opening a SEP-IRA is straightforward. You contact a bank, brokerage, or investment company, fill out a straightforward form (usually one page), and you are done. There is no annual paperwork, no filing with the IRS, and no compliance forms. You can open a SEP-IRA as late as the tax filing important date for that year (usually April 15, plus extensions).

A Solo 401(k) requires more setup. You must adopt a plan document (your provider usually supplies a template), and you may need to get an Employer Identification Number (EIN) from the IRS if you do not already have one. Once your account balance reaches $16,000 or more at year-end, you must file Form 5500-N with the IRS each year. This form is free to file but requires accurate information about your account.

If you later hire employees, the rules change. A SEP-IRA requires you to contribute the same percentage for each employee as you contribute for yourself. A Solo 401(k) does not have this requirement (though you may choose to offer it as a benefit). This is another reason some self-employed people choose a Solo 401(k) — it keeps the door open to hiring without automatically increasing your retirement contributions.

When each account makes sense for your situation

Choose a SEP-IRA if you want simplicity, do not expect to hire employees, and do not think you will need to borrow from your retirement savings. It takes minutes to open, requires no annual filing, and lets you contribute a solid amount each year. It works well for freelancers, consultants, and contractors who want a straightforward way to save.

Choose a Solo 401(k) if you earn high income and want to save the maximum amount, if you might need to borrow from your account in an emergency, or if you think you may hire employees later and want to avoid automatic contribution requirements. The extra paperwork is manageable if the higher contribution limit or loan option matters to you.

If you are unsure, start with a SEP-IRA. You can open one quickly, and if your situation changes (your income rises, you want to borrow, you hire someone), you can roll the SEP-IRA into a Solo 401(k) later. The IRS allows this rollover without penalty.

Frequently Asked Questions

Can I have both a SEP-IRA and a Solo 401(k) at the same time?

No. If you have a Solo 401(k), you cannot also contribute to a SEP-IRA in the same year. However, you can roll a SEP-IRA into a Solo 401(k), or close one and open the other. Talk to your tax preparer or the financial institution holding your account about the mechanics of switching.

What happens to my SEP-IRA or Solo 401(k) if I get a W-2 job?

You keep the account and can continue to contribute to it as long as you have 1099 income. If you only have W-2 income and no self-employment income, you cannot contribute to either account that year. The money already in the account stays there and continues to grow tax-deferred.

Can I withdraw money early without the 10% penalty?

Generally, no. Both accounts penalize withdrawals before age 59½. A Solo 401(k) offers a workaround: you can borrow from it instead of withdrawing. A SEP-IRA has no loan option. There are narrow exceptions (disability, medical expenses, first-time home purchase) that may explore, but they are rare and require IRS approval.

Do I need an EIN to open a SEP-IRA or Solo 401(k)?

For a SEP-IRA, no. You can use your Social Security number. For a Solo 401(k), it depends on your provider, but many require an EIN. You can get a free EIN from the IRS website in minutes if you need one.

What if my 1099 income varies from year to year?

Both accounts are flexible. In a year when your income is low, you can contribute less or nothing at all. In a high-income year, you can contribute more (up to the limit). This flexibility is one reason these accounts work well for freelancers and contractors whose earnings fluctuate.